What is an Umbrella Company?

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Instead of going through the process of setting up their own limited company, self-employed contractors have the option to work via an umbrella company. However, choosing to use an umbrella company will bring advantages. Still, these advantages are very much dependent on your IR35 status and whether you will be contracting for a long time, so should you choose to use one?

What is an Umbrella Company?

An Umbrella Company is also known as a PAYE umbrella. They give self-employed contractors the option of joining them and working through them instead of starting their own limited company, meaning that they avoid the issues that come with it.

Once a contractor joins, they will then become an employee. So, the umbrella behaves as an intermediary between the contractor and the end client. As a result, the company will manage the administration. This will involve handling taxes and such. Meaning that contractors won’t be expected to manage the day-to-day running of a company.

The umbrella company will also deal with payroll while managing invoices and receiving payment for the work you undertake. You will then be paid through PAYE. All costs such as taxes, national insurance contributions, and workplace pension payments being deducted.

Why Would You Use an Umbrella Company?

Many challenges can come with running a limited company. Opting to run one might not be the best option for contractors. If you are new to contracting, you might not want the stress or the hassle associated with setting up a limited company immediately. Along with this, if contracting is something you will only do for a short period of time, then the process of setting up a limited company won’t be worth it.

Therefore, opting for an umbrella company will remove the burden associated with the administration. This means that contractors won’t need to maintain any company records and VAT returns. In contrast, they won’t need to follow all responsibilities they would usually have to as the director of a limited company.

So, when it comes to being paid, the contractor will be required to keep timesheets. Which they will then submit to manage the payroll. However, if you choose to carry out all contracting via an umbrella company, you will not be able to take advantage of the tax efficiency that comes with a limited company because pay is subject to PAYE regardless of the IR35 status.

IR35 Status and Umbrella Companies

Contractors can work on contracts that are both inside or outside IR35 because the off-payroll status is only applicable to contracts but not the contractors.

For those contractors who are inside IR35, then they might opt to use an umbrella company as a way of minimising the administration as well as the complexities surrounding tax and national insurance.

It is still possible to run a limited company while working on contracts inside IR35. It’s also possible to run a limited company but also work through an umbrella company.

Advantages and Disadvantages

Advantages

  • Contractors are given rights as they are considered an employee which means that they will get sick pay, holiday pay, maternity, and paternity pay including a pension.
  • Less Administration – an umbrella company will manage all invoicing, timesheets, payment chasing, and payroll.
  • Perfect for short-term contractors – there is no requirement to go through setting up a limited company and all of the elements that go with it.

Disadvantages

  • Tax Efficiency – you will be on payroll via PAYE, and that will mean that your income is considered a salary, which means that all fees will be deducted.
  • Less Control: If you choose to opt for an umbrella company, it will mean that you have less control than you would if you were running a limited company. This would include managing the finances, administration as well as how you pay yourself.
  • Some umbrella companies are not compliant – some will promise to lower your tax liability and increase the amount you take home, which means it is imperative to carry out research. More importantly, it would help determine whether they are a member of the Freelancer & Contractor Services Association.

The Process of How Umbrella Companies Work

  1. Once you have secured a role, the umbrella company will sign a contract with the end client. You will also be expected to sign a contract with your umbrella company.
  2. You will be required to document all of the time you spend working on projects in your timesheets. Which will then be passed to the manager, who will sign it off.
  3. Timesheets will be passed to the umbrella company. They will then begin the process of invoicing the end client.
  4. The umbrella company will receive the payment, and at this point, they will process your payment. You will be paid with all tax, national insurance contributions, pension contributions, and the fee for their service deducted. However, it is possible to reclaim allowable expenses, all of which will be processed by your umbrella company.
  5. You will receive a payslip from your umbrella company. This will show all of the deductions as well as your take-home pay.

This guide provides you with a broad overview of what an umbrella company is. However, the company you choose will be based on your specific situation. Be diligent, it’s worth researching and speaking with professionals.

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